The government is introducing new rules, called basis period reform, that will affect the reporting of profits for unincorporated entities e.g., sole-traders, partnerships, LLPs.

Basis period reform will align profits of general partnerships, LLPs and sole-traders with the UK fiscal year. Any of these entities, therefore, who do not have accounting years that end between 31 March and 5 April will be affected.

Old rules

Prior to April 2024, business profits were assessed to tax on ‘current year basis’ i.e. based on profits for the date to which accounts were drawn up. This date did not need to match with the fiscal year i.e. 5 April and so businesses prepared accounts for periods that ended at various points in the year. While businesses had various commercial reasons for drawing up accounts that was not coterminous with the UK tax year, special rules meant profits of those businesses were taxed twice in the opening years of trade. These profits were called overlap profits. Overlap profits would be carried forward and relieved or increased if there was either a change of accounting date or the business ceased to trade.

New rules

The new rules from tax year 2024/25, align trading profits for non-coterminous accounting periods to the tax year such that taxable profits will be based on profits of accounting periods that fall within that year on a time apportionment basis. There will be a requirement to undertake this exercise annually, however, it is likely that businesses will need to initially prepare calculations using estimates and subsequently making amendments once the actual accounting profits are known.

What does this mean?

Due to the nature of the reforms, businesses could experience a temporary increase in tax liabilities. There will almost certainly be cashflow considerations that will need to be taken into account and the scale will invariably mirror the size of the business. Even with small businesses, careful planning will be required to ensure manage potential cashflow issues.

While the alignment occurs in tax year 2024/25, the impact will begin to be felt from tax year 2023/24, which is the ‘transition year’. In the year of transition, profits will be based on the period from the end of the prior year to 5 April 2024. As an example, a business with a 30 April year end will have profits of a 23 month period assessed to tax in tax year 2023/24 i.e. profits for the period 01.05.22 – 05.04.24.

Part of the transitional arrangements enable profits for the year of transition to be spread over five years after deducting overlap profits. Businesses may elect to accelerate the taxation of the transition profits at any point during the five year spreading period. For sole-traders ceasing to trade or members exiting a partnership, however, the remainder of any transition profits will be taxed in the final year and this will potentially result in a significant tax liability.

Businesses that have not already changed their accounting period will need to consider this to avoid having to time-apportion profits based on two separate sets of accounts.

There are potential implications for tapering of personal allowance, pension annual allowance thresholds, High Income Child Benefit Charge, etc. and as such transitional profits are treated as standalone in the income tax calculation although some anomalies will continue.

What options do I have?

1. You can change your accounting year end to 5 April 2024, this is by far the simplest option and we can assist you all the way.
2. You keep your year end as it is currently. However, every year an adjustment will need to be made when completing your self-assessment tax return to tax profits to 5 April. This may mean that you will need to provide us with an estimate of your profits for the additional period. We would therefore have to file based on provisional figures and then revise the tax return later once the true figures for the later accounting period are known (assuming they cannot be finalised prior to).

How can Gerald Edelman help?

We will prepare calculations showing you the impact specific to your tax return and explain the options available to you. Meet our self-assessment advisors.

Please feel free to contact our tax team if you would like further explanations in the meantime.